1 4 pts Consider the original lottery example What interest

1. 4 pts Consider the original lottery example. What interest rate (compounded annually) would make you indifferent to the options of S17 MM today or 26 payments (beginning at t-0) of S1 MM for the next 25 years?

Solution

$17000000 should be the PV of the 26 payments that constitute an annuity due, as payments start from t0. So, 17000000=1000000*PVIF of annuity due(r,26) Solving for r, we have 17 = PVIFAD(r,26) The interest factor is 16.6221 for 4%, and 18.4131 for 3% The exact rate can be found out by simple interpolation as below: r = 3+ (18.4131-17)/(18.4131-16.6221) = 3.79%